COVID debt – a Sustainable debt?

By Rex Chiu, GLOBUS Correspondent

Since SARs-CoV-2 struck the UK in late February/ early March of 2020, the UK government has been forecasted to spend £280 billion pounds to support the nation’s businesses, jobs and the wider economy. While the furlough scheme in this spending package has won major applause for maintaining employment levels and has been adopted globally, the implications of this additional spending are just starting to emerge. The Office for Budget Responsibility estimates that by the end of this year, the budget deficit will be 19% of GDP (equivalent to £394 billion), and the national debt will rise to 105% of GDP. So, although this spending has averted a major socio-political crisis as people’s livelihoods were (and still is) protected, will we need to pay this debt in the future? And if so, how will we do it? Who will be the eventual winners and losers of this additional spending and debt? 

Modern Monetary Theory: unlimited government spending? 

Intuitively, this additional spending (and hence debt) will need to be paid at some stage. Like households, governments need to maintain a budget balance in the long run — what goes out needs to come back in. Or do they? Proponents of the Modern Monetary Theory (MMT) claim that they don’t — governments, with a monopoly in their currency, should view fiscal policy in the same way as they view monetary policy, and dispose of the idea of a balanced budget. 

In brief, MMT proponents argue for unlimited quantitative easing (money printing) until the economy reaches full employment and inflation returns to normal, ignoring debt-to-GDP ratios in the process. Put in the context of COVID-19, this means governments would have unlimited fiscal power to support jobs, businesses, expand their welfare policies and finance the green new deal without having to eventually cut spending, increase taxes or bear any consequences par inflation. 

Yet, many scholars argue that the MMT is flawed for a number of reasons; the most important two include the loss of confidence in a currency (as a currency no longer acts as a store of value) and neglect of the relationship between employment and inflation, as specified by the Philips curve. Unlimited quantitative easing supported by the MMT also means investors will hold tangible assets (like housing) and stocks rather than money as these things keep their value better, creating asset bubbles and hurting savers and people on fixed incomes, which is an effect no government would want to see. 

So what comes out of this discussion? For one, it is clear that governments cannot spend indefinitely in the long run — this would cause people to lose confidence in an economy and chaos to set in. Early signs of this effect include the rapid rise in value of Gold and Bitcoin in July and November respectively. Yet, in the short run (as in now, when COVID-19 has not been suppressed), governments do have a lot of fiscal power to utilise — with low employment and inflation, governments may run large budget deficits to save jobs and promote green growth without inflation spiralling out of control or people losing confidence in them.  

Critics of the MMT also lend some value to the argument of ignoring debt-to-GDP ratios, at least under current conditions. With ultra-low interest rates (Bank of England’s base rate sits at 0.1%), governments can spend more while paying less in interest. With interest rates remaining low and inflation significantly higher than it, the real value of the national debt also dwindles with time, as the nominal increase in tax revenue outpaces the increase in the debt. With inflation maintaining around 1-2% since the early 2000s, it can be expected that the debt would reduce by around 1-2% (the inflation rate – interest rate) per year. Yet, this calculation assumes interest rates remain low, and the debt (probably financed by government bonds/ gilts) not being pegged to inflation. 

Paying the debt 

While inflation will gradually chip away at this massive debt, the question remains: how will the rest of the debt be paid? Will it be increased taxes? Or will it be reduced spending (austerity), as was the case after the 2008 financial crisis? Although we are still a long way off before the crisis ends and the bills have to be paid, some comments made by the chancellor Rishi Sunak and the public may offer some indication as to where the money will come from. 

The first area that will bear the consequences will probably be aid — £4 billion per year can be saved by cutting the aid budget from 0.7% to 0.5% of UK’s GDP. While this may not impact the local British community, many have voiced concern and disagreement over this course of action. From an ethical standpoint, this neglects Britain’s colonial history and its role in creating many of the problems the global South currently face, including climate-related risks, poverty and unstable political systems. And from an international recognition viewpoint, this adversely affects the UK’s soft power and its image as a reliable political and strategic partner

Yet, apart from cutting overseas aid, the government is out of options in terms of spending cuts. Many have argued that austerity cuts after the financial crisis were implemented too soon, creating sluggish economic growth and widespread poverty. In the 2019 elections, the Conservative party also promised to “level up every part of the United Kingdom” and “share prosperity across the country”, meaning spending for local communities cannot be cut either, for it would be politically embarrassing to do so. 

With expenditure unable to be cut, the only viable option to pay off the UK’s debt would be using taxes. Yet, the Conservative manifesto has also promised to not raise the rate of income tax, VAT or National Insurance, which collectively generates more than half of the government’s tax revenue. Hence, that only leaves tax raises on other taxes and closing the tax gap as the only viable options. 

(https://www.statista.com/graphic/1/1172872/government-income-in-the-uk.jpg

Many have argued that it is both fair and reasonable to implement a tax specifically for the super-rich. The combined wealth of UK’s billionaires has risen by £25 billion during the COVID-19 pandemic, while society as a whole has gone poorer. In the words of Keir Starmer, leader of the Labour party, “those with the broadest shoulders should bear the greatest burden”.  It is reasonable that the super-wealthy, whom hoards vast amounts of cash without necessarily investing them back into the economy, should be taxed substantially more, as it generates large amounts of tax revenue without hurting consumer expenditure in an economy; and it is fair that those who benefit from this crisis of humanity should give back to society. Indeed, even some members of the super-rich support this move, giving no excuse for the government not to look into the idea of a wealth tax.  

Yet, a bigger jewel, a lost source of tax revenue that has spanned decades, but is still neglected by journalists, academics, and politicians alike is tax avoidance. HM Revenue & Customs estimates that for the 2018-2019 financial year alone, UK’s tax gap, or the difference between taxes that should be paid and actual taxes collected, amounted to £31 billion; that is 4.7% of tax liabilities that should legally and morally be paid under the current tax framework but is not paid for whatever reasons. Put in context, that is 11% of what the government has additionally spent due to COVID on supporting the British economy. Hence, it can be argued that apart from a wealth tax, it also makes sense, and is totally justified, that the government tries closing tax evasion loopholes and make these people who are enjoying public services, yet not paying for them, put their part into relieving the government of its debt. 

Of course, the combined effects of inflation, aid spending (however unjustified), wealth tax and tax avoidance are still insufficient to relieve Britain of its debt. The last part of the solution now comes down to the economy as a whole — can the British economy, after being flooded with government spending and green investments, rebound quickly in the near future to increase the tax base, also known as the aggregate value of things that can be taxed by the government? 

According to Hepburn et. al. (2020), green investments and recovery policies like infrastructure, energy efficiency, education and natural capital investments are highly regarded by economists and central bank officials to deliver both economic and climate goals. Their qualitative survey results are backed by quantitative data from a study conducted by Lahcen et. al. (2020), who demonstrate that government subsidies on green investment policies yield a return of around 164%. Hence, with the British government spending £12 billion (and the private sector contributing up to three times more) on green investments, assuming returns are similar, this means that the government would gain at least £20 billion back in tax revenue, although when this materialises is not specified. 

Concluding remarks 

Whatever way the government chooses to pay this debt, it is clear that this cannot be a repeat of austerity after the 2008 financial crisis. With multiple scholars including Ginn (2013) finding that austerity hurt the poorest, most marginalised members of society the most, while the richest can continue their quest for wealth, it is unfair, unjust and unreasonable to repeat the whole process again, as it only serves to exacerbate wealth inequality in the country. While tax raises and some degree of spending cuts will need to be taken to repay the national debt, this time, unlike after the financial crisis, it must be done in an equitable way, where the ones who have gained most from this pandemic, coincidentally also the most capable ones, should shoulder the bulk of the responsibility. 

Header Image via Unsplash

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